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While purchasing jeans or a t-shirt, you should have checked the price tag, but most of us ignore the tax bifurcation. But when it comes to buying something big like a house or a car, most of us analyse the tax bracket before purchasing. What about when you are looking to invest in Alternative Investment Funds largely known as AIFs?
When we invest in an Alternative Fund, we are supposed to know the tax implications that come with it. In this blog, we will discover the tax criteria of alternative investment funds. But first, let’s briefly understand the alternative investment funds.
What are Alternative Investment Funds?
An alternative investment fund is different from traditional investment options. It invests in a variety of investments, such as private equity funds, hedge funds, venture capital funds, and a few more. It allows investors to invest in a dynamic range of investments and is usually managed by professional fund managers.
AIFs can be a great tool used by HNIs to diversify their portfolios. It has the potential to generate returns that may be more than what we see in a conventional equity market. But as an investor, you must understand the tax implications associated with it. This plays a vital role in choosing the right AIF category to invest in.
Now, let’s understand the tax implications of different alternative investment funds’ categories.
Category I and II AIFs:
The Finance Act of 2015 announced a taxation rule for Category I and II AIFs. These investments have been granted a pass-through, which means the money generated by the fund is taxed at the investor’s level, not at the fund’s level. The investor is responsible for paying the tax on the income he has generated.
The fund is not subject to any tax on the income generated from the investment. But, if the funds’ income is measured as business income, then the same amount is taxed on the fund.
Let’s understand different scenarios, like long-term capital gains, short-term capital gains, dividends, and income.
- Long-term capital gains – If an investment has been held for more than a year in Category I and II, it is termed as Long-term Capital Gains (LTCG). These investments are taxed at the rate that applies to long-run capital gains. Usually, long-term capital gains are taxed at 10% and are listed on stocks, and unlisted stocks are taxed at 20%.
- Short-Term Capital Gains – Investors who invest while aiming at short-term capital gains under Alternative Investment Funds Category I and II are subjected to a 15% tax, but it also depends on their tax bracket.
- Dividend Income – Dividend income under AIFs is taxable as per the investor’s individual tax-rate.
- Interest Income – Any interest income gained through Category I and II is also taxable as per the tax slab of an investor.
Category III AIFs:
In this category, AIFs are subject to taxation for all income, whether it is investment income, capital gain, or business income. The pass-through system has not been implemented in category III alternative investment funds. All four types of income are taxable but at different rates.
You can read in detail about AIFs categories, here.
Conclusion
Alternative Investment Funds have become quite popular in the current Indian landscape as they offer diversification and have the potential to generate higher returns. But, it is important for any investor to be informed about the tax implications associated with AIFs. It helps the investor make better and informed decisions while they are aware of the tax implications.
